US Economy Could Avoid Recession Despite Big Drop in Inflation Inflation could be headed for a big drop, and prices could cool significantly without the US having to deal with a recession, according to Bank of America. Strategists point to the inverted 2-year and 10-year Treasury yield curve, the bond market’s notorious recession gauge that has successfully predicted numerous downturns, most recently in 1990, 2001, and 2008. When short-term yields rise above those of longer-term bonds, it has historically signaled investors believe a downturn is coming. Last week this difference steppeend to a full percentage point, marking the steepest inversion in over 40 years. However, this time around, the indicator is signaling a hard landing for inflation, not a downturn in the economy. BofA strategists believe the US economy still has the power to avoid a deep recession. “While curve inversion near historical extremes has garnered higher recession probabilities from models, we think curve shape is more a function of expectations for declining inflation than a deterioration in growth,” strategists said. This is because forward real yields, which represent the market’s expectations of bond yields adjusted for the rate of inflation, have only seen a “modest drop” in the short-term. This suggests investors expect the Federal Reserve to pull back on interest rates slowly. Investors have been watching closely for signs of potential recession since last year as the Fed raised interest rates aggressively to temper inflation. Rates are now at their highest level since 2007, with Fed officials expected to hike rates again in July. Markets are pricing in an 87% chance the Fed will make a 25 basis-point increase, lifting the Fed funds rate target to 5.25-5.5%. The New York Fed has estimated a 71% chance of recession in the near future. Given the situation, BofA strategists still believe the US economy will successfully avoid a recession without any massive inflation problems. “Curve inversion at historically extreme levels does not currently reflect elevated recession risk, but instead is largely related to expectations for cuts alongside inflation converging to target,” the strategists note. It’s true that the US could experience a significant decrease in inflation and still stave off a recession. With many market watchers eyeing the inverted yield curve as a potential indicator of negative economic events, the fact that the indicator is signaling increasing inflation while suggesting recession is less likely, is certainly worth noting. Source:Business Insider